Portfolio Design: A Modern Approach to Asset Allocation

VENTURE CAPITAL

Venture capital was the investment of the late 1990s. At the time, investors were clamoring to get into this investment class because of the storied returns earned by the VC firms that had provided startup financing for firms like AOL, Compaq, Cisco, Sun, and others. A healthy IPO market was crucial to the VC firms’ successes. In 1999 alone, returns on small cap growth stocks exceeded 40 percent. So investors sought to invest in new growth companies, and investment banks eagerly brought many VC projects to market. With the collapse of the tech boom, VC firms suffered a sharp reversal of fortune, and investors turned to other hot products such as buyout investments.

What distinguishes VC investments from others? Andrew Metrick has written an insightful book about venture capital investments which he describes as a textbook, but which has some very interesting chapters for the investment professional. At the beginning of the book, Metrick lists five main characteristics of venture capital:

1. A VC is a financial intermediary, meaning that it takes the investors’ capital and invests it directly in companies.

2. A VC invests only in private companies.

3. A VC takes an active role in monitoring and helping the companies in its portfolio.

4. A VC’s primary goal is to maximize its financial return by exiting investments through a sale or an initial public offering (IPO).

5. A VC invests to fund the internal growth of companies.

The investments can be at different stages ...